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RRSP Investors: 2 Undervalued Bank Stocks to Buy for Decades of Passive Income

Retirement
Image source: Getty Images

Written by Aditya Raghunath at The Motley Fool Canada

The Registered Retirement Savings Plan, or RRSP, is an investment vehicle that allows Canadians to significantly lower their tax bill. Any contributions made to the RRSP reduces your taxable income. For instance, you can contribute up to 18% of your taxable income or a maximum of $30,780 (whichever is lower) towards the RRSP in 2022.

So, if you earned $100,000 last year, you can contribute $18,000 towards the RRSP, lowering your taxable income to $82,000. However, if you earned $300,000 in 2022, your RRSP contribution will be limited to $30,780.

Canadians can hold several qualified investments in the RRSP, ranging from stocks to mutual funds and even bonds. Keeping these factors in mind, here are two undervalued TSX stocks RRSP investors can buy for decades of passive income.

Bank of Montreal stock

Companies such as the Bank of Montreal (TSX:BMO) have a fairly simple business model. They typically accept deposits and use these funds to provide loans to corporates, individuals, and families. But during periods of economic recessions, demand for loans declines at a rapid pace. Moreover, existing borrowers find it difficult to repay outstanding loans leading to a rise in delinquency rates.

As investors are worrying about an economic recession in 2023, BMO stock is already trading 24% below all-time highs. But this pullback has increased the dividend yield to a tasty 4.9%.

Bank of Montreal is among the five largest banks in Canada, providing it with a wide economic moat. Additionally, the Canadian banking sector is heavily regulated, which suggests the barriers to entry are high, thereby limiting competition.

The conservative nature of BMO and its peers has allowed them to maintain dividends even during the financial crisis of 2009. In the last 20 years, BMO stock has increased dividends by 7.6% annually, making it attractive to income-seeking investors.

Priced at 8.8 times forward earnings, BMO stock is trading at a discount of 23% compared to consensus price target estimates.

Bank of Nova Scotia stock

Another big Canadian bank is the Bank of Nova Scotia (TSX:BNS), which currently yields 6.3%. Bank of Nova Scotia has increased its dividends in 43 of the last 45 years, and since March 2003, these payouts have risen by 8.5% annually.

Unlike most other TSX banks, BNS is looking to expand aggressively in emerging economies such as Columbia, Peru, Mexico, and Chile. So, BNS is a blue-chip stock that offers you geographical diversification.

While a widening presence in emerging markets will allow BNS to benefit from long-term growth, investors should also brace for volatility, given the risks associated with investing in these regions.

Additionally, BNS relies heavily on wholesale funding compared to other Canadian banks. Here, banks use deposits from non-customers to support the underwriting of the loans it then disburses. But wholesale funding is costly compared to traditional customer deposits due to higher interest yields associated with these loans.

Down 30% from record highs, BNS stock is priced at seven times forward earnings. It’s also trading at a discount of almost 15% to consensus price target estimates.

The post RRSP Investors: 2 Undervalued Bank Stocks to Buy for Decades of Passive Income appeared first on The Motley Fool Canada.

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Fool contributor Aditya Raghunath has no position in any of the stocks mentioned. The Motley Fool recommends Bank of Nova Scotia. The Motley Fool has a disclosure policy.

2023